Arizona marijuana clinics roll out creative funding options

As the Arizona Department of Health Services prepares to randomly select applications for medical marijuana dispensaries on Aug. 7, potential operators are looking for financing.

Most banking executives have made it clear they want nothing to do with the budding medical marijuana industry, which comes as a result of voters approving the Arizona Medical Marijuana Act in November 2010. That means dispensaries are looking for creative ways to secure financing for the construction and expansion of their facilities.

One way small businesses finance their enterprises is through outside funding, but the law requires dispensaries be formed as nonprofits, and investors can’t receive returns on their investments in charitable organizations. As a result, some dispensaries are creating for-profit shell companies that let individual investors make money. Another option is lenders that charge high interest rates for loans.

In their application process, dispensaries were required to show they had $150,000 in capital to start their business.

Gerald Gaines, founder of Compassion First LLC, said he doesn’t think $150,000 is enough to start a dispensary in the metro Phoenix area.

He said only a handful of banks across the country are willing to work with dispensaries, but they don’t promote themselves.

“If you’re not able to have a bank, you have to run your business as a cash business,” he said.

ADHS Director Will Humble said he will be hiring experts to ensure the dispensaries are in compliance with the law and not using a shell game to hide their assets.

He plans to issue a request for proposals this fall to gather bids from accounting firms to audit dispensary books.

“We will rely on the accountants that we hire to help, whether it’s interest rates, capital sources or fair market value,” he said. “We’re going to ask them to look at all of that.”

Federal regulators have not prohibited banks from doing business with the medical marijuana industry, said Ryan Suchala, president of Bank of Arizona.

He said his bank made an internal decision to steer clear of the industry, just as it has decided against doing business with other industries, such as payday lenders or bill collectors.

“It is challenging for a bank to distinguish the legitimate medical marijuana dispensaries from those that are perhaps being too aggressive or not following the spirit of the law,” Suchala said. “It’s our job to truly know our customer. If we can’t do that, there are times when banks put a blanket ‘we won’t do business with that industry,’” he said.

He said the money-making models that are expected to emerge in the medical cannabis industry need to be closely monitored by potential investors.

“As an investor, you really need to be aware of who you’re doing business with and the management team you’re investing in,” Suchala said.

Kris Krane, managing partner of 4Front Advisors LLC, a Phoenix-based consultant for dispensary operators, said running a dispensary on an all-cash basis is dangerous.

“That produces potential security risks that hopefully will be mitigated with robust security plans submitted to DHS,” he said. “They will have to spend additional capital making sure their operations are even more secure.”

Suchala said cash on hand is the least of their security worries.

“The marijuana is worth more than cash,” he said.

Even credit card companies are cautious of working with dispensaries in California and Colorado, which also allow operation of medical marijuana businesses, Krane said.

“There are some that are offering these services in those states, but most have pulled out of this as well,” Krane said.

Krane said he also is seeing individual investors in California charging high interest rates on their loans to the nonprofit dispensaries.

A 50 percent interest rate is difficult to justify, even if investors are putting their money in a risky business, he said. However, a 14 percent interest rate might not raise as many eyebrows, he said.

“The majority of the dispensaries will get their financing from individual investors through loans and separate companies to help capitalize,” he said. “I would be wary of having a third-party finance the business. You’re still getting into the questions whether you’re truly operating as a nonprofit, and DHS will be looking into that.”